If you want to retire rich, there's no better place to start than with an IRA. Setting up an IRA is fast and easy and can even give you a valuable tax break in the process. But once you get your IRA set up, the next question is huge: What stocks should you buy?
Later in this article, I'll give you five good ideas for stocks that go well in an IRA. But first, let me explain why putting stocks in an IRA can be especially valuable, giving you benefits not just now but throughout your entire investing career.
Why IRAs are so important
We all know that saving for retirement is important -- more important than ever right now, with company pensions mostly a thing of the past and with cracks appearing in the foundations of Social Security and other government assistance programs. But with all the alternatives available, why is an IRA the best place to start for many people?
IRAs have three big strengths. First, contributions to traditional IRAs are tax-deductible, meaning that if you put the maximum of $5,000 into an IRA, your contribution can produce up to $1,750 in tax savings right away. With contributions for 2011 allowed until your April tax return is due, putting money in an IRA is one of the only ways to get tax savings for your 2011 return even after 2012 has already begun.
Also, as with other types of tax-advantaged retirement accounts like 401(k)s, the income from your IRA investments doesn't get taxed right away. That can save you a bundle over the years.
But most important, IRAs give you complete flexibility with your investments. Unlike a 401(k), where you're stuck with whatever investment options your employer gives you, you can pick just about any stock, bond, or mutual fund you want for an IRA.
So which stocks should you start out with in an IRA? Here's a hierarchy to consider:
- The best way to take advantage of the tax benefits of an IRA is to put stocks that would produce big tax liabilities in them first. So two great examples are Annaly Capital (NYSE: NLY ) and American Capital Agency (Nasdaq: AGNC ) . Both have high dividend yields that aren't eligible for the IRS' lower tax rate on some dividend stocks. Both have potential for capital appreciation above and beyond the huge dividends they pay. And with the Fed reputedly on hold with interest rate rises until at least the middle of next year, both Annaly and American Capital Agency should see their interest margins hold up fairly well -- barring unforeseen changes.
- Another advantage of IRAs is that you don't have to worry about the complications that arise when a company splits into two. That's one reason to consider Textron (NYSE: TXT ) . The stock has plunged in recent years, but speculation has arisen that the company could spin off its Bell helicopter or Cessna airplane divisions to try to unlock value for shareholders. Similarly, NovaGold (AMEX: NG ) expects to spin off its NovaCopper division in February or March. Investors who own these shares outside an IRA will have some tax complications in having to divide their tax basis after the splits -- but IRA investors don't have to worry.
- Lastly, if you're making a short-term call on a stock, then putting it in an IRA means you don't have to pay short-term capital gains tax when you sell. For instance, after plunging 58% in 2011, Bank of America (NYSE: BAC ) has already bounced back sharply this year. If you think the stock could surge further but that its longer-term prospects aren't as bright, then owning the stock in an IRA lets you make the most of your strategy.
Combining stocks like these with a more broadly diversified investment, such as a mutual fund or ETF, can be exactly the answer you need to make the most of your retirement.
You may have until April to fund an IRA for the 2011 tax year, but why wait? The longer you put it off, the better the chance that you'll miss out on tax-protected growth. Given how easy it is to set up an IRA, it could be the easiest step you ever take toward a prosperous retirement.
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Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter here.